(Recently CGAP and the World Bank Group hosted the first-ever Global Seminar on Financial Literacy and Consumer Protection. More than 200 people worldwide tuned in via videoconference to hear about current practice and knowledge and debate what it all means.)

On September 3, I attended the Global Seminar on Financial Literacy and Consumer Protection where a hot topic was whether consumers of financial services need protecting, from themselves and from financial institutions that have want to sell them products that are ill suited or downright dangerous. And if consumers do need more protection, should this be done through regulation, information, financial education, or some other strategy that will make people want what’s good for them, understand what they’re getting, and use finance properly?

In the Consumer Protection session, Martin Gruenberg (vice chair of the U.S. Federal Deposit Insurance Corporation) serve as our tour guide through the twists and turns of the U.S. subprime crisis. Before telling us how FDIC was hoping to fix the mess, he brought out several key lessons from this cautionary tale:

• Consumers need to be educated — through financial literacy programs, disclosures on loan contracts, and so on . But equipping consumers with the right knowledge and skills is rarely enough.
  Clear, strong, substantive rules on loan underwriting and marketing need to be in place. Financial education is too frail a defense when products are so complex; marketing is sometimes deceptive; and lenders, brokers, appraisers, and others involved in the business of mortgage-making have incentives to get to “yes” and favor loan volume over quality. Rules should be made by regulators. Rules should be strongly enforced, with strong sanctions for noncompliance.
  It’s perhaps surprising that in the United States (and South Africa – see presentation by Gabriel Davel, CEO, National Credit Regulator) regulators’ insistence that lenders focus on borrowers’ repayment capacity is seen as radical. At its core, isn’t finance about risk management – by lenders, regulators, and investors? And isn’t credit risk pretty central? We’re seeing the consequences for soundness of the whole financial system when risk management is sorely lacking.
  Reckless lending is not a good idea, as we can now see from the daily headlines… and it’s worth figuring out how to rein it in. Regulators on the hot seat have concluded that it is sometimes necessary to ban certain products and practices, like hefty prepayment penalties.
  There is great value in simplicity for financial products, especially for those at the less sophisticated end of the consumer spectrum.

A tension ran through the morning sessions because these messages on consumer protection were controversial: Financial education is not enough and regulation may need to get tough to protect consumers. Commentators were expressing worries about regulatory over-reaction and excessive paternalism, as well as doubts that regulators can keep up with innovation (some of it legitimate and constructive, some of it less so) and set rules before the next crisis.

Sendhil Mullinaithan brought a fresh perspective to the debates by raising two concepts that can confound good financial decision-making – temptation and confusion. With a picture on the screen of well-intentioned people taking an escalator to their gym (presumably to work off the calories saved on the conveyance), he cut through the usual academic jargon favored by economists and psychology researchers to consider real human behavior and what happens when people do not consistently do what they know to be good for them. For example, we know we should save for a rainy day and not get overextended, but the temptation is strong to get something now and pay for it later.

Behavioral psychologists and financial regulators might seem strange bedfellows. But by early afternoon we were reaching the same conclusions from the experience of a half dozen regulators and behavioral psychologists: We can and must educate financial consumers, but facts and logic and skills — the traditional tools of this education — will often fall short in ensuring “sensible” consumer behavior.

Consumers also need help from regulation because it can help ensure that products are simpler and less confusing, that deceptive features and practices are limited, and that consumers — and financial institutions – don’t transact business they will later regret.
This debate, about the tensions among protection, access, and innovation, is healthy and necessary within the microfinance community.